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The worst of the European economic crisis lies ahead

Hope springs eternal amongst European policymakers. As yet another example of such hope, last week Germany’s finance minister, Wolfgang Schauble, joined a chorus of other European policymakers in asserting that the worst of the European economic crisis was now behind us. His assurance would have carried more weight had he not made similarly soothing reassurances at each stage of the European crisis over the past two years. It would also have carried more weight had there been the slightest indication that Europe was emerging from the renewed economic recession into which it has again sunk.

The key point that European policymakers refuse to acknowledge is that economic growth holds the key to the resolution of the European sovereign debt crisis. For without economic growth it is very difficult to restore balance to a country’s public finances. Not only does a deepening economic recession erode a country’s tax base and automatically increase a country’s cyclically related public expenditures, it also increases a country’s public debt to GDP ratio as the country’s level of GDP declines.

Economic growth also holds the key to improving Europe’s social and political climate. A disturbing aspect of European political development over the past year has been the growing signs of an anti-austerity backlash across the European periphery that has to raise questions as to whether the periphery will stay the policy course. Greece now borders on the ungovernable, social and political unrest has become the order of the day in Portugal and Spain, and the brief period of political stability in Italy that Mario Monti’s government brought to that country is now coming to an end.

The sad reality is that, notwithstanding what European policymakers would want us to believe, there is little reason to expect that the European economy will return to economic growth anytime soon. For not only do the high frequency economic indicators suggest that Europe is sinking ever deeper into recession, the very policy course on which the European periphery is embarked would point to a prolongation and a deepening of the recession in the year ahead. If there is one thing that European policymakers should have learned from 2012, it is that severe budget austerity at a time of economic recession and of a domestic credit crunch is hardly conducive to a revival in economic growth.

It is understandable that someone like Wolfgang Schauble might want to cheerlead Europe, especially ahead of Germany’s crucial general elections in September 2013. However, one must hope that he does not allow his own rhetoric to blind him to the need for a change in policy course without which Europe’s economic and political prospects for 2013 appear to be rather grim.

Discussion: (1 comment)

I wish I could fully agree that it’s clear that growth holds the answer. It normally would, and economies should be managed so that it does.

But Europe may have crossed the line beyond which the higher rates that would follow growth are instead a catalyst for collapse. I believe that Japan certainly has crossed this line. In that clearer case, even marginally higher rates would bring about the long anticipated Japan collapse. The debt they have accumulated during decades of ever declining interest rates cannot be refinanced should money demand from growth reverse the trend.

Is Europe there? It’s not clear. But they’re heading that way. So too are we for that matter.

I don’t think this is debatable in the case of Japan. I recognize that it is in the case of Europe or the US. But, in the meantime, I think the idea that that the “growth solution”, always true in the past, may fail after you reach a certain debt load is an under recognized truth.